Tuesday, June 19, 2007

After Shake-Up, What Now for Yahoo?

Should Yahoo stop trying to beat Google at its own game? Should it step up the pace and grow even larger through mergers and acquisitions?

As Jerry Yang takes over as Yahoo’s chief executive, all eyes are on the next steps that Mr. Yang, the company’s co-founder, untested as a top executive, will take to rejuvenate the troubled business.

In recent weeks, the News Corporation informally broached the idea of merging its MySpace unit into Yahoo, people briefed on the discussions said. The loose proposal, which was made through intermediaries, has yet to generate meaningful negotiations, but it was not immediately dismissed by Yahoo, these people said.

The resignation Monday of Terry S. Semel as chief executive may have prevented any discussions from moving forward. As part of such a deal, the News Corporation would want to take as much as a 25 percent stake in Yahoo. That would value MySpace above $10 billion. It is unclear whether Yahoo wants MySpace or would accept Rupert Murdoch, the News Corporation’s chief executive, as such a large shareholder.

Yahoo declined to comment, as did the News Corporation.

Short of a merger or an outright sale, few moves would seem more drastic than outsourcing the search business to Google and reassigning its people and dollars to projects like reinvigorating the Yahoo portal, buying hot start-ups and taking other initiatives that would differentiate Yahoo from the Internet search leader.

As radical as these ideas may seem, they have been contemplated by people in and outside Yahoo for a long time. And although Yahoo said it had no plans to get out of the Internet search business, the idea has again become fodder for debate.

“They should take a hard look at the search business, and it may well be the right time to stop trying to out-Google Google,” said Jim Breyer, an experienced Silicon Valley venture capitalist and a principal financial backer of Facebook.

Search is about locating information on the Web, but the business of search is about selling small text ads alongside those search results. It has been the hottest business on the Internet for the last few years and one that helps Google make more money in a quarter than Yahoo does in a year. Yet many have made the case for Yahoo to abandon the business for a number of reasons.

Competing with Google in search is costly, and there are no guarantees that Yahoo will ever match Google’s ever-improving algorithms.

Even it if it succeeds in narrowing the gap somewhat, Yahoo could make more money by simply outsourcing search to Google.

Google, whose search and search advertising technology is featured on many sites, including AOL, makes twice as much as Yahoo for every search, according to Wall Street analysts. Because Google passes an estimated 80 percent or more of the advertising revenue it earns on those sites to its search partners, Yahoo would come out far ahead.

What is more, some Yahoo insiders say that Mr. Semel’s quest to catch up with Google with a new advertising system, known internally as Project Panama, starved many other projects of much-needed resources.

But giving up on the search business also carries enormous risks for Yahoo. As advertising dollars move the Internet, marketers have increasingly wanted to be able to purchase all types of online ads on all types of Web sites from a single source — whether small text ads or graphical and even video ads.

“I don’t think they need to get out of the search business,” said Douglas Anmuth, a securities analyst with Lehman Brothers. “They just need to do it a whole lot better than they are doing it now. That would mean they could get a greater share of advertising budgets.”

Yahoo executives have said they hope to do just that. “We have invested a great deal in search,” a spokeswoman, Joanna Stevens, said. “We intend to remain a principal in search.”

The management shake-up may not portend any bold shift in strategy. Mr. Yang and Susan L. Decker, who was promoted to president on Monday, said that Yahoo’s plan was to stay the course, while rebuilding morale, and attracting and retaining top talent.

They intend to use a three-pronged business model developed under Mr. Semel that includes selling search and display advertising on the Yahoo portal, which attracts some 500 million visitors each month; selling ads on the Web sites of a growing list of partners, like eBay, Comcast and some 260 newspapers; and becoming an ad broker on sites across the Web through RightMedia, a company that Yahoo has agreed to acquire and that runs a marketplace where advertisers bid for ad space in real time.

“I believe that Yahoo has all the assets it takes to win, and we’re well positioned to do just that,” Mr. Yang said on Monday.

Abandoning search and Project Panama at this time would be wrenching. The bulk of the initial investment has already been made, and Yahoo has said that the Panama technology would eventually become central to selling other types of advertising. Ms. Decker said Monday that the new system would begin this quarter to deliver double-digit increases in revenue for every search, slightly ahead of schedule.

That is the kind of news that would typically brighten the mood of investors. But it was eclipsed by word that advertising on the Yahoo portal was going to be weaker than expected, erasing for now any gains from improvement in search advertising.

So after a brief run-up in its share price after hours on Monday, following the announcement of Mr. Yang’s appointment, Yahoo shares fell 49 cents yesterday, to $27.63; the company’s shake-up seems to have left investors with more questions than answers.

A Yahoo executive who agreed to speak only on condition of anonymity said that ceding the search business to Google was not an option being considered now.

But that could change, the executive said, adding: “The Panama effort is actually really working. The question is whether the slope of the improvement is such that we’ll catch up, or get close enough. My guess is that the executive team is going to give it six or nine months and see if we are there, and if not, they’ll ask the question again.”